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Underwriting a Loan Transaction where the Borrower is a Family Trust

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By Dan Harkey

A property owner may choose to hold title to a property by creating a family trust. The “JQSmith” Trust dated February 31, 2020 will become a separate entity similar in nature to any other entity, Corp, LLC, or partnership, but with different rules, regulations, and standards of care.  “John Quincy Smith, as trustee” will sign loan documents on behalf of the family trust. The body of law that governs family trust is the California Probate Code, Division 9, Trust law (15000-19403), and Division 11, Construction of Wills, Trust, and other Instruments (21101-21700). States in the USA treat issues relating to family trust somewhat differently.

Establishing a family trust creates entity that is beneficial for estate & tax planning purposes, including distribution of assets to designated Heirs/persons/beneficiaries upon death of the trustor/trustee. The existence of a trust was intended to provide certain liability protections, but I have observed judges making the decision that disregard their existence. Many judges interpret the law to achieve their own ideological or political objective(s), rather than to apply the law as written and intended by the applicable legislature.

There is no government agency that requires registration for the activation of a family trust. However, a notarized certification will be required to obtain title insurance for a real property loan transaction.

A family trust usually requires three parties:

  • Trustor(s)– The person(s) who creates the family living trust, either revocable, or irrevocable. There may be one or more trustor(s), such as husband and wife. There are many forms of trusts, for example, a children’s remainder trust or a trust representing some group. The intent of a trust is usually to protect accumulating assets such as cash, real estate, stocks, bonds, businesses, and other valuables, from excessive taxation and perseveration of capital.  The purpose of a trust may also include an attempt to protect assets from certain liens or creditors during life or upon death of the trustor. Although the trustor(s) conveys title into the trust, the trustor(s) will usually reserve some or all the benefits of owning the property placed in the trust during his/her/their life. The added purpose is to preserve some of the benefits for future beneficiaries.
  • Trustee(s)- The person who is authorized by the trust document to perform certain acts and sign the loan documentation for the trust. There may be one or more trustee(s). For, example husband and wife becoming trustees. This person(s) is/are considered the trust manager(s) with rights and obligations that are stated in the trust document. The trust document contains delegated rights, responsibilities and establishes who possess authority to act.
  • Beneficiaries- Are those whom the trustor designates to receive some future benefits of the trust assets as defined in the trust document. There may be one or more beneficiaries. The benefits are usually based upon the investment performance of the trust assets, and the distributions resulting from the trust, now and sometime in the future. Beneficiaries may be the children, relatives, or some designated organization, such as a religious group, foundation, education entity, or benevolent group, such as The American Cancer Society, or The Make A Wish Foundation.

A Trust Deed Document contains 3 Parties:

A deed of trust is a security instrument that a borrower will sign and record which will reflect a lien on a subject property. Terminology in deed of trust has similar words, but entirely different meaning or definitions.  A totally different conversation as a matter of understanding the process is that there is a trustor, trustee, and beneficiary in the language of a deed of trust.   Consider that a property owner who desired to obtain a loan and encumber real property.  Consider that they take title as an individual(s), not a family trust. We can use husband and wife, as joint tenant with right of survivor-ship.

  • Trustor(s) – Is the person(s) or entity who owns the property. The trustor is sometimes referred to as the grantor. The owner/trustor/grantor decides to borrow money and use the property as collateral for a loan. An encumbrance called a deed of trust will be drawn, signed and recorded against the property at the county recorder’s office. A deed of trust is also referred to as a security instrument. Public records will then reflect notice of that lien.
  • Trustee (s) – A deed of trust requires a third-party entity, generally a title company, to hold what is referred to as a bare equitable title on behalf of the beneficiaries, or investors in the loan transaction. The trustee is given three powers; 1) to foreclose 2) to re-convey and 3) to modify the trust deed per agreement. The trustee cannot benefit from the ownership but is hired only as a place holder in states that use trust deeds as recordable security instrument. The trustee is an intermediary that has a fiduciary responsibility to the stated beneficiaries. His/her job is to protect the beneficiary’s rights, and in the event of default, act in their best interest. Also, when a borrower/trustor pays off the loan, the trustee will re-convey, meaning remove the lien from public records, and return full ownership back to the borrower/trustor.

Some states use a security instrument called a mortgage, rather than a deed of trust.  A mortgage document only requires 2 parties.  One is the borrower/trustor, and the other is the lender/beneficiary.  There is no trustee required.

  • Beneficiaries – Are the investor/lenders/bankers who invest capital and receive a recorded deed of trust or mortgage document and promissory note signed by the borrower/trustor to hold as collateral for the consideration of the loan.

One family trust who owns the property may decide to borrow money using their property as collateral.  Another unrelated family trust may decide to become an investor/lender and use their capital to lend out to the property owner.

The investor/ lender family trust will become the beneficiary of the deed of trust. If the beneficiary of the trust deed also demanded to become the trustee under the deed of trust, would the person sign as an individual, or would the person sign as trustee on behalf of the family trust?

I would personally discourage this because this may alter the servicing relationship between the parties. The trustee of the deed of trust and the trustee of the family trust would have to sign the servicing agreement or an addendum wherein trustee under the deed of trust will take no actions that will alter the terms of the servicing agreement. The complexity here is not worth the bother.

In a court of law, either of the above parties will claim that they did not understand the ramifications. The tight-rope action should only be undertaken with the advice of their counsel and paid for by them.

The only practical solution is to have the title company who issued the policy of title insurance for the closed loan transaction to become the trustee under the deed of trust.

I chose to deviate of explaining the differences between the parties, property owners, and the lenders in a different context, but the underwriter must be aware of the separate-ness and the ramifications of dealing with each.

All the following conversation relates to the property owner as a family trust.

Loan Origination – Loan Application Process

The application package sent to the borrower/trustor/trustee will contain forms related to an individual or an entity depending upon whether the loan is for consumer purpose, or for business purpose. In most cases the individual(s) who create the trust is both the trustor and the trustee of the family trust. Your underwriting is almost like a hybrid of the two.

The question about consumer purpose vs business purpose arises.  If the occupant is a home owner who is the trustor and trustee, consumer laws prevails. The above is a broad statement.  Each circumstance is different.  Also, when a trustor creates a family trust and conveys/transfers title of the property into the trust, there is are California Revenue & Taxation Code, Transfer Tax Exemptions, R&T 11911 to 11930 relates to documentary transfer fees.  The code relating to transferring into or out of a trust is 11930. The exemption to avoid property tax reassessment for related parties is R&T Code 62(d), and 61(h). Consult your accountant or attorney for advice of this issue. Do not rely on this article for making your final decision.

  1. Business Entity Loan Application-in circumstances where the property is non-owner, and the loan is for business purpose.
  2. Personal loan application-in circumstances where the property is occupied by the trustor/trustee and the loan is for consumer purpose.
  3. Business Credit Authorization for the Trust-In most cases this requirement will be waived-applies as (1) above.
  4. Personal Credit Authorization for the Trustee-applies to (2) above.
  5. Bank Statements of the trust, or as an alternative the trustor/trustee as an individual.
  6. Year to Date Profit & Loss of the trust, or as an alternative the trustor/trustee as an individual.
  7. Current Balance Sheet-same as above.
  8. Disclosure regarding insurance requirement, authorization for the insurance agent or representative to communicate and provide the lender with requested information regarding coverage.
  9. 8821 Tax Information Authorization.
  10. 8821 tax information authorization, if required. This form authorizes the IRS to disclose your confidential tax information to the person that is appointed, usually the lender representative. The completion of the form may be voluntary be the borrower but required by the lender. The completed form with be sent to the IRS, who will in turn send the tax return to the appointed party. Certain lenders may have this requirement.
  11. 4506-T request for copy of tax return. The purpose is to allow the lender to retrieve past tax transcripts. The document must be signed and dated by the taxpayer or managing member that will give a third-party lender permission to retrieve requested data. Certain lenders may have this requirement.

Original Trust document and all related Amendments

  1. There are differing views on whether the complete trust should be obtained and read as part of the loan approval decision, or whether the statutorily authorized Certificate of Trust (discussed below) should be the sole source of information. My view is that the entire trust should be read to determine who are the trustors, trustees and beneficiaries. This gives the lender the contact information for all parties. If the trustor/trustee dies, then the lender can contact the beneficiaries, to continue.
  2. Does the trust give authority for one or more trustees to borrow, submit information on behalf of and sign the related documents encumbering the subject property? The purpose in reading the trust document, and especially the amendments, is that the trustor, trustee, and/or beneficiary might have changed.  The powers may have changed, and successor trustees may have replaced deceased trustees.
  3. Title Page, Trustee Identification Page, Signature Page, Powers Page, Any Amendments Thereto. Some Lenders will only request these three pages. This is suggested by some as incomplete.
  4. Trust certification (Probate Code section 18100.5) A trust certification may be prepared by the lender, the trustee or an independent source such as a title company and can be recorded. It certifies who are the trustor, trustee, and beneficiaries.  It establishes the authority to borrow and encumber, provide information and sign loan documents.  As part of Probate Code section 18100.5, the certification provides protection for lenders who rely on the information it contains.  However, a lender cannot rely on the trust certification if the lender has actual knowledge that the matters set forth in the certification are incorrect.  Therefore, some lenders believe it is best to not even get a copy of the trust itself.  However, the statute itself provides that simple possession of the entire trust document itself without more is not enough to prove that the lender has “actual knowledge”.
  5. The certification itself can, but is not required to, include excerpts from the original trust documents, any amendments thereto, and any other documents evidencing or pertaining to the succession of successor trustees. Dispositive provisions of the trust need not be attached.
  6. A lender may ask for copies of excerpts from the original, any amendments, thereto, and any other documents which designate, evidence, or pertain to the succession of the trustee or confer upon the trustee the power to act in the pending transaction, or both.
  7. Some borrowers are secretive and become irritated about all the contents of their trusts. If a lender requires a copy of a full trust rather than a trust certification there may be some offsetting liability with the lenders gained knowledge of issues within the trust document. Lender parties may be liable for damages, including attorney’s fees, incurred because of the refusal to accept the certification of trust in lieu of the request for full trust documents. The court may determine that the lender acted in bad faith in requesting the full trust documents.
  8. Federal Tax Returns for the trust.
  9. Attorney authority and enforceability letter-some lenders may wave this requirement. An attorney authority and enforceability letter is a letter addressed to the lender assuring the lender that the trustee has the authority he/she claims and has the power to undertake the loan process and obtain the loan. This letter can be obtained in addition to a Trust Certificate but is not necessary if the Trust Certificate is properly obtained and the lender has no actual knowledge contrary to the facts stated in the Trust Certificate.
  10. Some lenders may require that the Trustee as an individual, or another separate party, to sign a personal guarantee when the family trust holds a single or limited amount of assets.
  11. The title insurance company will require the trust document, or portions as explained above to document the authority of the trustee to act on behalf of the trust.

Dan Harkey

Business and Private Money Finance Consultant

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